Hedcor, Inc.

January 8, 2007 BIR RULING [DA-007-07] 34 (A) (1); 34 (H); RR 2-98; #016-2006; DA-718-2006 Hedcor, Inc. Hydro Electric Development Corporation 110 Legaspi Street, Legaspi Village Makati City Attention: Mr. Jose Venancio Batiquin Gentlemen : This refers to your letter dated December 21, 2006 requesting for confirmation of your opinion that: 1. The payments made by HDI in favor of the Municipalities do not qualify as a donation. 2. HDI's payment for the use of municipal resources and properties is an ordinary and necessary expense. 3. Since the payees are local government units the said expense is not subject to withholding tax. BACKGROUND Northern Mini Hydro Corporation (NMHC), is a domestic corporation duly organized and existing under and by virtue of the laws of the Philippines, with principal office address at 214 Obulan, Ambuklao Road, Beckel, La Trinidad, Benguet. It is registered with the Bureau of Internal Revenue under Revenue District No. 9 Cordillera Administrative Region with Tax Identification Number 001-946-904-000. TSEAaD Hydro Electric Development Corporation (HEDC) on the other hand, is engaged in the business of developing potential sites for hydroelectric power in the Province of Benguet. It has been registered as such pursuant to Republic Act No. 7156 otherwise known as "An Act Granting Incentives to Mini-Hydroelectric Power Developers and For Other Purposes" and its Implementing Rules and Regulations. It is presently registered as a VAT Taxpayer with the Bureau of Internal Revenue under VAT Registration Number 609-000134. On Dec. 6, 2006 BIR Ruling No. 016-2006 was issued to NMHC. One of the facts therein stated that NMHC entered into a Memorandum of Agreement (MOA) with the Municipality of Bakun dated January 15, 1991 and an amended MOA dated December 20, 1993 defining the terms and conditions for the construction, operation and/or maintenance of a mini hydro electric plant in suitable sites in the Municipality of Bakun, Benguet. SaHTCE Under the circumstances and stipulations of the MOA, the said BIR Ruling issued in favor of NMHC stated that: 1. The payments made by NMHC in favor of the Municipality of Bakun, Benguet clearly do not qualify as a donation. The MOA and amended MOA which embody the agreement between NMHC and the Municipality clearly reflect the intention of both parties to regard said payments as consideration by the latter for the use by NMHC of the municipal resource and property. The dependence of said payments on the existence of net sales before payment is made moreover belie the fact that it was the intention of NMHC to do an act of liberality in favor of the Municipality. Moreover, there is no reduction or increase of patrimony to speak of; 2. NMHC's payment for the use of municipal resources and properties is an ordinary and necessary expense since the use of said resources and properties is essential, necessary, and constitute the primary source of generated electricity for NMHC, hence, said expense or such use was or is being legitimately incurred in carrying on its business. 3. The income payments that NMHC pays as aforementioned to the Municipality of Bakun, Benguet constitute payment to government instrumentalities which are not subject to the expanded withholding tax under Section 4 of Revenue Regulations No. 12-94 amending Revenue Regulations No. 6-85. It is also not subject to any creditable withholding tax (CWT) under Revenue Regulations No. 2-98, as amended. On Dec. 15, 2006, likewise HEDC obtained BIR Ruling No. DA-718-2006 where HEDC stated that it entered into three (3) separate Memoranda of Agreement with the Municipalities of Tuba, Sablan and La Trinidad, all of Benguet Province, defining the terms and conditions for the construction, operation and/or maintenance of a mini hydro electric plant in suitable sites in the said municipalities. In the aforementioned ruling, given the terms of the MOA, this Office ruled that: The payments made by HEDC in favor of the Municipalities of Tuba, Sablan and La Trinidad, all of Benguet Province clearly do not qualify as a donation. The MOA which embody the agreement between HEDC and the said municipalities clearly reflect the intention of both parties to regard said payments as consideration by the latter for the use by HEDC of the municipal resource and property. The dependence of said payments on the existence of net sales before payment is made moreover belies the fact that it was the intention of HEDC to do an act of liberality in favor of the municipalities. Moreover, there is no reduction or increase of patrimony to speak of. * BIR REPLY The National Internal Revenue Code, as amended, provides: "Section 34 "xxx xxx xxx "(H) Charitable and Other Contributions. "(1) In General. Contributions or gifts actually paid or made within the taxable year to, or for the use of the Government of the Philippines or any of its agencies or any political subdivision thereof exclusively for public purposes, or to accredited domestic corporations or associations organized and operated exclusively for religious, charitable, scientific, youth and sports development, cultural or educational purposes or for the rehabilitation of veterans, or to social welfare institutions, or to nongovernment organizations, in accordance with rules and regulations promulgated by the Secretary of Finance, upon recommendation of the Commissioner, no part of the net income of which inures to the benefit of any private stockholder or individual in an amount not in excess of ten percent (10%) in the case of an individual, and five percent (5%) in the case of a corporation, of the taxpayer's taxable income derived from trade, business or profession as computed without the benefit of this and the following subparagraphs. SCEHaD "(2) Contributions Deductible in Full. Notwithstanding the provisions of the preceding subparagraph, donations to the following institutions or entities shall be deductible in full: "(a) Donations to the Government. Donations to the Government of the Philippines or to any of its agencies or political subdivisions, including fully-owned government corporations, exclusively to finance, to provide for, or to be used in undertaking priority activities in education, health, youth and sports development, human settlements, science and culture, and in economic development according to a National Priority Plan determined by the National Economic and Development Authority (NEDA), in consultation with appropriate government agencies, including its regional development councils and private philanthropic persons and institutions: Provided, That any donation which is made to the Government or to any of its agencies or political subdivisions not in accordance with the said annual priority plan shall be subject to the limitations prescribed in paragraph (1) of this Subsection; Pursuant to the above-quoted provisions of law, donations to charitable and other institutions are deductible subject to certain qualifications. However, in order to determine whether said contribution may be considered a donation it is necessary to determine first what constitutes donation or gift. A gift is generally defined as a voluntary transfer of property by one to another without any consideration or compensation therefor. 1 The definition of a donation is found in the Civil Code. Article 725 of said Code defines donation as: TEDHaA ". . . an act of liberality whereby a person disposes gratuitously of a thing or right in favor of another, who accepts it." Donation has the following elements: (a) the reduction of the patrimony of the donor; (b) the increase in the patrimony of the donee; and, (c) the intent to do an act of liberality or animus donandi . 2 In this particular case, the payments made by HDI in favor of the Municipalities clearly do not qualify as a donation. 3 The MOA which embody the agreement between HDI and the said municipalities clearly reflect the intention of both parties to regard said payments as consideration by the latter for the use by HDI of the municipal resource and property. The dependence of said payments on the existence of net sales before payment is made moreover belie the fact that it was the intention of HDI to do an act of liberality in favor of the municipalities. Moreover, there is no reduction or increase of patrimony to speak of. cIaCTS Ordinary and necessary expense, pursuant to the Tax Code, as amended, constitute the following: "Section 34 (A) Expenses. (1) Ordinary and necessary trade, business or professional expenses. (a) In general. There shall be allowed as deduction from gross income all ordinary and necessary expenses paid or incurred during the taxable year in carrying on, or which are directly attributable to, the development, management, operation and/or conduct of the trade, business or exercise of a profession." Simply put, to be deductible from gross income, the subject expense must comply with the following requisites: (a) the expense must be ordinary and necessary; (b) it must have been paid or incurred during the taxable year; (c) it must have been paid or incurred in carrying on the trade or business of the taxpayer; and (d) it must be supported by receipts, records or other pertinent papers. 4 Using the guidelines enunciated above, HDI's payment for the use of municipal resources and properties is an ordinary and necessary expense since the use of said resources and properties is essential, necessary, and constitute the primary source of generated electricity for HDI, hence, said expense or such use was or is being legitimately incurred in carrying on its business. The income payments that HDI pays as aforementioned to the Municipalities constitute payment to government instrumentalities which are not subject to the expanded withholding tax under Section 4 of Revenue Regulations No. 12-94 amending Revenue Regulations No. 6-85. 5 It is also not subject to any creditable withholding tax (CWT) under Revenue Regulations No. 2-98, as amended. 6 This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be ascertained that the facts are different, then this ruling shall be considered void. aSCHcA Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. (28 C.J. 620; Santos vs. Robledo, 28 Phil. 250). 2. Manuel G. Abello, Jose C. Concepcion, Teodoro D. Regala and Avelino V. Cruz vs. Commissioner of Internal Revenue, C.T.A. Case No. 4296. October 7, 1991. 3. BIR Ruling No. 016-2006. 4. Commissioner of Internal Revenue vs. General Foods (PHILS.), Inc., G.R. No. 143672. April 24, 2003. 5. BIR UN Ruling No. 410-95 dated 11-20-1995. 6. BIR Ruling No. 008-05 dated 7-28-2005.